Is This Decline The Real Deal?

Is this stock market decline the "real deal"? (that is, the start of a serious correction of 10% or more) Or is it just another garden-variety dip in the long-running Bull market? Let’s start by looking for extremes that tend to mark the tops in Bull markets.

Extremes Eventually Revert to the Mean

There's little doubt that current measures of valuations, sentiment, leverage and complacency have reached historic extremes. Many analysts have posted charts depicting these extremes, and perhaps the one that distills well multiple extremes into one metric is Doug Short’s chart of the S&P 500’s inflation-adjusted Regression to the Trend, another way of saying mean reversion or reverting to the mean.

I have added two red boxes: one around the peak reached just before the Great Crash of 1929 (81% above the trend line), and one around the current reading (86% above the trend line).

That the current reading exceeds the extreme that preceded the Crash of 1929 should give us pause. And little comfort should be taken that the bubble of 2000 reached even higher extremes, as that should likely be viewed as an outlier rather than the harbinger of the New Normal.

What this chart demonstrates is the market tends to overshoot to the upside or downside before reversing direction and once again reverting to the mean. Other than a very brief foray below trend line in 2009, the S&P 500 has been at or above the trend line for the past 20 years. While the Gilded Age boom of a century ago stayed above the trend line for over 30 years, more recent history suggests that markets that stay above the trend line for 20 years are getting long in the tooth.

Extremes in Risk Appetite and “Risk-On” Asset Allocation

One measure of risk appetite is junk bond yields, which as Lance Roberts shows in this chart, have reached multi-year lows:

Money managers’ appetite for the “risk-on” asset class of equities is similarly lofty:

Previous readings near the current level preceded major stock market declines—though high readings have been the norm for the past few years without presaging a major drop.

Can Extremes Be Worked Off Without Affecting Price?

From the Bullish point of view, these extremes have been worked off in relatively mild downturns in the seasonally weak periods of February to April and August to October:

Let’s look at a chart of the S&P 500 (SPX), with a focus on the seasonally weak periods:

Rather significant declines in indicators such as the MACD have translated into relatively brief, shallow declines.

From the Bull’s perspective, all the extremes in valuations, sentiment, leverage and complacency have been worked off in modest declines that haven’t reached the 10% threshold of a correction. So why should the present period of seasonal weakness be any different?

One potential difference in August 2014 is the sheer number of current financial/market extremes. Analyst John Hampson prepared a list of all-time records that is impressively long:

Lowest ever US quarterly GDP print that did not fall within a recession

?And this week:

11. Lowest HSBC China services PMI since records began

12. Lowest ISE equity put/call ratio since records began

If we had to summarize the current set of extremes in risk appetite, valuations and sentiment, we might state the Bear case as: These extremes characterize the tops of asset bubbles that inevitably deflate in dramatic fashion, despite the majority of participants denying the asset class is in a bubble.

Conversely, we might state the Bull case as: The fundamentals of low interest rates, abundant liquidity, slow but stable growth and rising corporate profits support current measures of value, confidence and risk appetite.

For context, let’s go back in time to the Great Housing Bubble circa 2006-07, when the official and mainstream media narrative denied that housing had reached bubble heights even as the housing market was increasingly dependent on often-fraudulent stated-income (a.k.a. liar loans), interest-only adjustable rate mortgages (ARMs) for sales and mortgage originations.

A report by the U.S. General Accountability Office (GAO) found that almost 80% of all interest-only adjustable-rate mortgages (ARM) and Option ARMs nationwide were stated-income in 2006. In effect, prudent risk management had been thrown out the window. But participants chose to focus on the supposedly solid fundamentals of housing to rationalize their confidence in what was an increasingly obvious Ponzi scheme based on fraud and borrowers who were bound to default once the bubble popped.

In other words, even as valuations, risk appetite, complacency and Bullish sentiment were reaching extremes, participants and Status Quo observers were confident that these bubble valuations were the New Normal.

Those who are confident that the current stock market is fairly valued have to explain why the many current extremes are different this time from previous asset bubbles, and provide an explanation of why extremes can continue indefinitely or be worked off without affecting price more than a few percentage points.

Indeed, what characterizes Bull markets is their ability to work off extremes of complacency (i.e. low volatility) and overbought conditions with only modest declines in price (for example, the S&P 500 is currently down 3.4% from its closing high around 1,988).

But the weight of these numerous extremes is significant, and a detached observer would naturally wonder if such a wide spectrum of extremes can be worked off without affecting price much.

The prudent observer would also ask: Have stocks been pushed to their current valuations by these extremes, or are these extremes merely temporary spikes of exuberance that have little to do with the fundamentals driving valuations higher?

It’s a critical question. For if extremes in risk appetite and sentiment have underpinned the market’s rise, then as these tides recede, price will inevitably follow.

If these extremes are merely temporary spikes that can dissipate without effecting price, then we have to ask: If this is the case, then what are participants afraid of?

We know participants are afraid of something, because the Put/Call Ratio—a measure of participants buying hedges (put options) against a downturn—has skyrocketed to a multi-year high in the past week:

This ratio has traced out a declining channel for the past two years. If nothing fundamental has changed, then what are we afraid of right now?

The Challenge To The Bulls

Those who are confident in the Bull case—that rock-solid fundamentals will drive stocks higher—have a daunting task ahead: they need to explain away the obvious spike in fear/caution, and explain why all these extremes in valuations, sentiment, leverage and complacency have no real bearing on the rock-solid fundamentals.

But given that the psychology of bubbles is characterized by precisely this rationalization of why extremes don’t matter, Bulls must also explain why their rationalizations don’t mark this as the top of an asset bubble that is remarkably similar in terms of extremes to recent bubbles in housing and stocks.

In Part 2: Prepare For The Bear, we take a look at changing fundamentals that may affect the market’s five-year Bullish bias. We’ll look at how the fundamentals of the Bull case have been weakened or threatened, and determine whether indeed we are witnessing a key moment of direction-reversal in the markets.

It isn't original so I'll quote the guy with the beard and sandwich sign: The End Is NEAR!

When the GOP threw the budget into the freezer, we got the sequester correction. If the GOP takes the Senate and Senate Committees, the federal government will be perfectly gridlocked with House and Senate vs White House. Obama would have to veto every thing the GOP shoves at him because neither the Senate nor the House would be able to override veto decisions, so stagnation and sequester will be happening. The market will not approve and so when the winds of this crap-a-thon blow through to Wall Street, we'll see a lot more than X+1 reasons why prices are shaky.

You're assuming manipulation is only to the upside. Do you realise how much money can be made on the downside if you have inside knowledge? The gains to the upside have be grinding on now for several years. The same amount can made, in a flash, to the downside. You don't think these mother fuckers pulling the levers don't know this and haven't planned accordingly. You don't think the Blanfeins and Dimons don't know exactly when QE ends? All that is needed is a nice cover story for why the market crashed that deflects attention and scrutiny from the central banks and primary dealers. Furthermore, the distraction that has people begging the central banks to intervene is even better. Rather than going after them with pitch forks and ropes they want people to come to them on their hands and knees.

These mother fuckers have it all sorted. The only bind they are in is choices, so many choices: WWIII, Ebola outbreak, dirty bomb in NYC, blow up multiple shopping malls in a co-ordinated attack. I mean, what's the CIA, FBI, Mossad supposed to do with so many exciting choices. I feel for them.

Very well stated, Sir. They are sending out trial ballons on all fronts, to see the reaction. I would expect it to be coordinated, so it looks like a black swan. Maybe all of them, plus a few ideas still sitting in a think tank in Virginia or Tel Aviv.

My connection between treasuries (non correlated) and equities (wrongly correlated) is simply that what's good for one is good for the other. So sure...I was chasing momentum in treasuries last year and got whacked by Taper...but I see no intrinsic problem post "betazoid maassacre" last fall not at least trying to get out on the dance floor here.

Still haven't pulled the trigger yet though. Being greedy on the treasury trade I guess...

'Mean reversion’ as a predictor is rather silly when you think about it. The prices didn’t ‘revert’ to the mean, they moved then you drew a new regression line – after the fact. If they plummet or soar off the top or bottom margins, you’d draw a new line, perhaps angled down, or possibly steeply higher. The current mean doesn’t draw prices like a magnet, but moving averages can, only because big players use them to establish positions, thinking everyone else is doing the same, in prophetically self-fulfilling fashion.

Nope--don't try to call a top until you see this shit go hockey stick parabolic. On a brighter note--I expect, since it is all so choreograhed by bureaucrats that you will not even have to be a good trader to telegraph the, "volatility". lol

I suspect this to be propaganda by the jews to try to show that they were in the land 2000 years ago and had the Romans not destroyed the Temple they would have inhabited the land ever since. We all know they have no reason to want to live in the City of David.

Dip into the normal running of the bull market. If you're not buying into this with everything you got, you're a fucking sucker. This market isn't going to stop going up until it goes to zero and it's going to take a cataclysm of bibilcal proportions to make that happen. A couple of dozen blackies in Africa with some STD they got from sticking their cocks in fruit bats and monkeys, the Ukranians fighting a civil war and the Heebs bombing the shit out of some rag head, terrorist, dirt-worshipers ain't gonna change things.

No. If it corrects a bit too much the Fed will come back in with lollipops to give the big money one last shoot to get out while the suckers pile in. Today was am interesting day and right at an inflection point in several indexes. If she holds we'll get at least a dead cat bounce to next fridays opex and then decide. A big mess is coming but the Fed WILL give the big boys one chance to get out or insure their positions

Given the amount of manipulation, liquidity pumps and outright lies by those "supposedly" in charge (hello FED), I would guess the eventual drop in the markets whenever it may occur will be something never before witnessed.

We have now undeniably seen three FED engineered bubbles during the 21st century which is not even 15 years old. The internet bubble popping in 2000-2001 followed by the housing bubble in 2002-2008. We now have stocks and junk bonds at record high levels which makes very little sense besides money being basically free thanks again to our friends at the Federal Reserve (unless you are a saver or pensioner).

Anyone with half a brain knows the stock and junk bond markets shouldn't be priced anywhere close to where they are today.

But it seems to me that those in the "know" also expect to be able to exit markets before the eventual collapse begins.

Think of the Michigan Wolverines football stadium of 100,000+ slowly being filled over 2 hours time. No problem.

But set off a blast or something else to panic the crowd and very few people would be able to hit the exits without a complete lockdown.

Have we been lulled into complacency by the extraordinary actions taken by central banks and governments over the last six years? This is a key question we must face. Have these actions really worked or merely masked over major flaws and problems? And just for fun, consider that by not demanding the right kind of growth and by throwing money at problems we have only delayed and added to festering issues that face us in the future.

Modern Monetary Theory often referred to as MMT to its many believers removes much of the risk ahead and guarantees that we will always be able to muddle forward. MMT also known as neochartalism is a economic theory that details the procedures and consequences of using government-issued tokens and our current units of fiat money. Newly acquired tools like derivatives and currency swaps are suppose to allow us to print and manipulate away problems. What I'm seeing develop is an "almost surreal" feeling of indifference towards reality. More on this subject in the article below.

Who cares? We all know that the markets don't reflect thet health of the economy anymore. Hell, they don't even reflect the health of the MARKETS anymore. If you're trading in these markets, any of them, then you're gambling. You might win, you may even have some steps to take to increase your chances of winning or to soften the sting when you lose ... but you're still gambling and not playing anything even remotely close to fundamentals. So if you chart out past occurrences and look for trends, well good on ya, Bro. It just has little interest to me, possibly even of less interst would be another article on picking the top and getting ready for the coming Winter (oh wait, that's part 2 that I can read if I subscribe ...).

I'm working at a job I hope I've made resilient enough to last thru the next few decades, one that I like and that doesn't kill me to do. I keep training and learning, keep looking for new avenues to move in to ... try to stay as flexible as I can. I'm done running the numbers on what my investments need to do in order for my retirement to come thru, I'll just keep working as long as I enjoy it, and when I don't enjoy it anymore or I can't work than I'll move in with family and we'll relive our childhoods together.

But thanks anyway, CH-S. It does give me some comfort to know you're checking to see if the lights are still on over at Wall Street.

2 years after Bernanke and Blankfein assumed their positions as heads of their respective organizations, the American Economy entered into the famous recession of December 2007, which was kept secret from the public until December 2008, a month after the election and which probably kept the Democratic Senate from being filibuster proof.

During the Q1 of 2009 estimates of the global loses ranged from $65 trillion to over $100 trillion.

There was only one thing that could save the global and US economy: a stock market rally on the NYSE.

It was up to Bernanke and Blankfein to deliver and deliver they did.

They rallied the DJIA from 6500 to almost 16500 today. A powerful tranquilizer had been unleashed upon the American consumer.

The Bernankes and Blankfeins of Europe and Asia followed suit, and the global markets rallied, demand reappeared and nations imported and exported as they had before the bubble burst.

IS THIS THE REAL DEAL?

No, it isn't.

If the market doesn't just decline politely but crashes, we will be back where we were in the Q1 2009.

Which will make being under the Sword of Damocles like being at ClubMed.

My prediction is that soon there will be a scary shakeout, out of which the "manipulators" will make heavy profits which they will put to use pushing the DJIA over 18000 and with a few breaks all the way to 19995.

In my view, no. As long as the Fed is not raising rates or selling bonds (mopping up all the excess liquidity injected the past five years) there is going to be a floor under stocks (although Dow infinity is now in jeopardy).

Also, the market is denominated in dollars, and as long as the value of those dollars is declining, again, it puts a floor under the price of stocks (in that they are declining in value even if they don't decline in price). So I am watching the dollar and it is gaining a bit here but I don't see a catalyst for a change in the overall direction of the greenback (which is down).

But I am net short at this point because the selling is triggering downward technical signals. I'm just not all in on my shorts (yet).

In my view, no. As long as the Fed is not raising rates or selling bonds (mopping up all the excess liquidity injected the past five years) there is going to be a floor under stocks (although Dow infinity is now in jeopardy).

Also, the market is denominated in dollars, and as long as the value of those dollars is declining, again, it puts a floor under the price of stocks (in that they are declining in value even if they don't decline in price). So I am watching the dollar and it is gaining a bit here but I don't see a catalyst for a change in the overall direction of the greenback (which is down).

But I am net short at this point because the selling is triggering downward technical signals. I'm just not all in on my shorts (yet).

The secongd longest and third longest periods between the S&P reaching new highs from previous highs both happened after the last two crashes and both were ridiculous bubbles and this bubble has extended now for over 17 months with more new highs recorded than any comparable period since 1950 that this data is from.

I am now betting that S&P does not reachga new high agan until 2019 or even 2020.

It has already "corrected" more in the last 9 days than any period in the past 64 years in such a short time